The Contribution of Bank Regulation and Fair Value Accounting to Procyclical Leverage

Our analytical description of how banks’ responses to asset price changes can result in procyclical leverage reveals that for banks with a binding regulatory leverage constraint, absent differences in regulatory risk weights across assets, leverage is not procyclical. For banks without a binding constraint, fair value and bank regulation both can contribute to procyclical leverage. Empirical findings based on a large sample of US commercial banks reveal that bank regulation explains procyclical leverage for banks relatively close to the regulatory leverage constraint and contributes to procyclical leverage for those that are not. Fair value accounting does not contribute to procyclical leverage.